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UK corporate environment

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1. Macro environment - Global growth slowing, particularly in Europe. UK growth expected to be 1.2% this year but Brexit risks loom large.
2. Momentum - business investment declining, household spending holding up on strong wage growth.
3. Operating costs – expected to rise due to tight labour market, wage growth close to a 11-year high. Commodity prices up 12.5% ytd.
4. Corporate stance – risk appetite lowest since 2008, focus on cost reduction and increasing cash flow.
5. Balance sheet – cash rich, credit cheap and easily available, pockets of debt risk in ‘cov-lite’ sectors, profits falling.
6. Risks – effects of Brexit and weak domestic demand, rising global geopolitical risk and protectionism also a worry for large UK corporates.

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UK corporate environment

  1. 1. UK corporate environment Ian Stewart, Debapratim De, Tom Simmons & Peter Ireson Economics & Markets Research, Deloitte, London
  2. 2. 2 UK corporate environment - key messages as at July 2019 1. Macro environment - Global growth slowing, particularly in Europe. UK growth expected to be 1.2% this year but Brexit risks loom large. Pages 3-7 2.Momentum - business investment declining, household spending holding up on strong wage growth. Pages 8-10 3.Operating costs – expected to rise due to tight labour market, wage growth close to a 11-year high. Commodity prices up 12.5% ytd. Pages 11-13 4. Corporate stance – risk appetite lowest since 2008, focus on cost reduction and increasing cash flow. Pages 14-16 5.Balance sheet – cash rich, credit cheap and easily available, pockets of debt risk in ‘cov-lite’ sectors, profits falling. Pages 17-19 6. Risks – effects of Brexit and weak domestic demand, rising global geopolitical risk and protectionism also a worry for large UK corporates. Pages 20-21
  3. 3. 3 Global growth to slow in 2019 GDP growth: Actual & IMF forecasts (%) Post- crisis trend 2018 2019 2020 ‘11 – ‘17 Advanced economies 1.8 2.2 1.8 1.7 Emerging markets 5.0 4.6 4.4 4.8 World 3.6 3.6 3.3 3.6 Emerging markets World Developed markets Forecasts Slowdown most pronounced in developed markets. Source: IMF World Economic Outlook Update, April 2019 Macro environment
  4. 4. 4 Brexit outcome seen as holding key to UK growth The independent forecaster the National Institute for Economic and Social Research expects the UK to enter recession next year in the event of a no-deal exit from the EU. By contrast, if a transition deal were to be struck, the Institute expects UK growth to accelerate modestly this year and next. Widerangeofpossiblegrowth outcomesdependingonBrexit Possible recession in the event of a no-deal Brexit Macro environment Growth is expected to average 1.2 – 1.4% this year Source: National Institute for Economic and Social Research, April 2019
  5. 5. 5 UK’s main export markets are slowing Activity is softening in all major export markets. Slower, but still respectable growth in the US is offset by significant slowdowns in a number of European economies, particularly Germany and Italy. GDP growth (% YoY) Share of total UK export market Average 2018 2019 forecast 2020 forecast ‘11 – ‘17 US (19%) 2.1 2.9 2.3 1.9 Germany (9%) 1.9 1.5 0.8 1.4 France (6%) 1.2 1.5 1.3 1.4 Netherlands (6%) 1.3 2.5 1.8 1.7 Ireland (5%) 7.3 6.8 4.1 3.4 Switzerland (4%) 1.7 2.5 1.1 1.5 Italy (3%) 0.0 0.9 0.1 0.9 China (3%) 7.6 6.6 6.3 6.1 Belgium (3%) 1.2 1.4 1.3 1.4 Spain (3%) 0.8 2.5 2.1 1.9 Sharply lower growth in Germany and a possible recession in Italy are particular concerns ** IMF World Economic Outlook Update, April 2019 *Numbers in brackets denote share of total UK exports in 2016, ranked by size German business confidence has fallen sharply Macro environment
  6. 6. 6 Interest rate expectations have fallen Markets now pricing rate cuts in US by the end of the year, UK rates expected to edge lower. 3-month deposit rates Current Market expectations for future 3-month rates* End 2019 End 2020 End 2021 UK 0.7 0.7 0.6 0.6 US 2.3 2.0 1.6 1.6 Euro area -0.5 -0.5 -0.5 -0.4 *Futures market implied expectation for 3-month deposit rates as at 04/07/19 Having assumed rate rises in the US, markets now pricing rate cuts this year and next Markets assume UK rates will fall slightly over the next two years Macro environment
  7. 7. 7 Sterling has traded sideways this year Remains more than 10% below its pre-referendum value against the euro and dollar. £ volatility sharply lower since March. Sterling volatility has fallen following the agreement to delay Brexit Brexit spike +0.2% since 01/01/2019 -0.7% since 01/01/2019 Macro environment
  8. 8. 8 UK growth slows in April due to one-off factors Sharp decline in car production and fading of Brexit stockpiling subdues growth. Momentum 0.5% 0.3% Source: ONS
  9. 9. 9 Consumer spending holding up, Brexit uncertainty tempers outlook Consumers’ confidence in their own financial situations remains robust thanks to real wage growth and low unemployment, but confidence in the outlook for the economy is keeping a lid on spending. Consumers’ confidence in the economy is at very low levels but confidence in their own financial situations is well above the post financial crisis average Momentum
  10. 10. 10 Surge in uncertainty is dampening investment Business optimism is down, Brexit uncertainty is weighing heavily on investment, which has hardly grown since the referendum. Investment fell 1.5% in 2019 Q1 compared to the same period a year earlier Demand uncertainty is holding back investment Momentum Deloitte CFO Survey: Business optimism Net % of CFOs who are more optimistic about the financial prospects of their company than three months ago 2019 Q2 = -35%
  11. 11. 11 CFOs expect a rise in operating costs A net 62% of CFOs expect operating costs to rise over the next 12 months. 2019 Q2 = 62% Operating costs
  12. 12. 12 Wage growth fastest since 2008 Companies are experiencing difficulty in recruiting and retaining staff. Unemployment is at a 44-year low Wages rising at their fastest pace in almost 11 years The number of people resigning from one job to take another is at its highest level in 18 years This is a sign of confidence in job prospects Operating costs Source: ONS
  13. 13. 13 Commodity prices up so far but global slowdown exerts downward pressure The World Bank sees a softening in commodity prices this year. World Bank commodity price forecasts 2018 2019 2020 Crude oil* ($/b) 68 66 65 Gold* ($/oz) 1,269 1,310 1,360 Energy -5.4% -1.4% Agriculture -2.6% 1.7% Metals & minerals -1.9% 0.8% * Average price for given year Source: World Bank - Commodity Markets Outlook, April 2019 Oil markets tightened in the first four months of the year due to supply issues in Venezuela, Russia and Iran But renewed trade concerns and weaker global growth have recently weighed on expected demand Operating costs
  14. 14. 14 Corporates are bullet-proofing their balance sheets The Deloitte CFO survey shows UK companies strongly favour defensive strategies. Risk appetite is at its lowest level since 2008. CFOs are placing emphasis on reducing costs, reducing leverage and increasing cash flow The lowest % of CFOs since 2008 think now is a good time to take greater risk onto their balance sheets Corporate stance 2019 Q2 = 4% 2019 Q2 = 37% 2019 Q2 = 19%
  15. 15. 15 Businesses have a particular focus on cutting costs and increasing cash flow CFOs are in defensive mode, although focus on reducing leverage has fallen. Emphasis on reducing costs and increasing cash flow Corporate stance
  16. 16. 16 Demand for credit has softened Appetite for new borrowing has fallen, especially among large non-financial corporates. Corporate stance Source: Bank of England Credit Conditions Survey - lenders are asked how overall demand for lending from businesses has changed in the last three months.
  17. 17. 17 Companies are flush with cash At the end of 2018, UK corporates held a record £747bn in cash, equivalent to 35% of GDP and almost one-third higher than in early 2016. Balance sheet Q4 2018, 35% of GDP
  18. 18. 18 Private sector debt levels below 2008 peak, but leveraged lending has risen significantly over recent years Pockets of risk in ‘cov-lite’, leveraged lending. 19 percentage point decline Lending to highly indebted companies has risen to pre-financial crisis levels Balance sheet Source: IIF Source: Bank of England
  19. 19. 19 Profits have fallen across the corporate sector The net rate of return on capital employed by UK companies has been trending down since the beginning of 2017. Balance sheet Source: ONS
  20. 20. 20 Brexit still the biggest risk for businesses Concern has risen over the risks posed by geopolitics and the threat of an escalation in trade wars. Risks
  21. 21. 21 Indicators highlight risk of a sharper slowdown High frequency UK data has disappointed, euro area activity softening and policy uncertainty elevated. Risks Lowest level since 2012 Long-term trend = 100
  22. 22. 22 Growth headwinds > tailwinds Headwinds • Brexit • mature recovery • global, Europe slowdown • trade tensions • bubble, debt risks Tailwinds • robust labour market • low inflation • corporate balance sheets in good shape • easy monetary policy • scope for fiscal easing
  23. 23. This publication has been written in general terms and we recommend that you obtain professional advice before acting or refraining from action on any of the contents of this publication. Deloitte LLP accepts no liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication. Deloitte LLP is a limited liability partnership registered in England and Wales with registered number OC303675 and its registered office at 1 New Street Square, London, EC4A 3HQ, United Kingdom. Deloitte LLP is the United Kingdom affiliate of Deloitte NSE LLP, a member firm of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”). DTTL and each of its member firms are legally separate and independent entities. DTTL and Deloitte NSE LLP do not provide services to clients. Please see www.deloitte.com/about to learn more about our global network of member firms. © 2019 Deloitte LLP. All rights reserved. Contacts Data for all the charts in this document was sourced from Thomson Reuters Datastream unless otherwise stated. Charts as on 4th July 2019. Ian Stewart Partner & Chief Economist 020 7007 9386 istewart@deloitte.co.uk Debapratim De Senior Economist 020 7303 0888 dde@deloitte.co.uk Tom Simmons Economic Analyst 020 7303 7370 tsimmons@deloitte.co.uk Peter Ireson Economic Analyst 011 7984 1727 pireson@deloitte.co.uk

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